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CHAPTER 2. HEALTH PLAN CHOICE 94
leads to a substantial re-allocation of enrollees across plans, although overall market
shares change modestly. With feasible risk-rating, the average enrollee risk at the
integrated HMO increases from its observed level of 0.99 to 1.49, and the network
HMO experiences a decline in average enrollee risk from 1.03 to 0.58. This reallocation
of households across plans substantially reduces overall insurer costs, by $44 per
enrollee-month, and increases total social surplus by just over $27 per enrollee-month.
The increase in social welfare represents approximately 11% of average insurer costs
in our sample.
A substantial fraction of the welfare gain is due to the highest and lowest risk
households making more efficient plan choices. Table 2.7 decomposes the welfare
calculation by household risk quintiles. The lowest and highest risk quintiles (aver-
age household risk below 0.36 and above 1.33) generate about three-quarters of the
welfare effect. This raises a concern that our calculation might be driven in part by
extrapolating plan costs out of sample. As Figures 2.5 and 2.6 illustrate, we observe
plan bids and costs only for average risk scores between 0.75 and 2.0. In contrast,
household risk ranges from 0.16 to 30.1. To address this, we truncate the cost differ-
entials between plans at their 0.75 and 2.0 levels and re-calculate the welfare numbers.
These calculations appear in the final columns of Tables 2.6 and 2.7. We view the
numbers based on truncated cost differences as a lower bound on welfare differences,
and the baseline numbers based on straight-line extrapolation as closer to an upper
bound. Truncating the cost differentials has little effect on the resulting assignment
of households to plans, but as one might expect, it reduces the welfare cost of ob-
served pricing to $5 per enrollee-month, or 2% of insurer costs, relative to the feasible
optimum.
It is also interesting to compare what is possible using prices based on observed
risk scores to what in principle could be achieved using both observed risk scores and
households’ private information. This calculation captures the extent to which private
information on risk constrains the efficiency of feasible relative to optimal risk-rated
pricing. Changing from feasible risk rated contributions to the first-best scenario
increases social surplus by between $2 and $8 per enrollee-month, depending on the
treatment of costs for extreme risk, or roughly 1-3 percent of insurer costs. One way